Stock Fund Inflows Hint at a Bumpier 2014

Some individual investors might be lulled into a trap

Record equity fund inflows alongside bearish calls from people who have highly questionable track records of making such predictions.

Stock fund inflows reached a record $320 billion for 2013, according to Lipper. Meanwhile, the likes of David Stockman, Robert Prechter and the anonymous “Tyler Durden” of ZeroHedge continue to warn of dire market outcomes.

At some point, stocks will decline, and these pundits might take a victory lap. But as the saying goes on Wall Street, even a stopped clock is right twice a day. Following the advice of market doomsayers has almost always led investors to miss out on strong returns.

That said, investors adding money to stocks today need to recognize that the gains of the past year were earned with extremely low volatility. The Dow Jones Industrial Average hit 52 record highs last year, while the Nasdaq Composite has been trading above 4000 since mid-December — though it still needs a significant gain from here to reclaim its all-time high. The S&P 500 Index closed the year at fresh all-time bests.

Yet the CBOE Volatility Index (also known as the VIX, or the “fear gauge”), which has averaged a reading just a bit higher than 21 since the market bottomed in March 2009, is trading about 40% below that average, and even below the average for the calendar year 2013. That’s low.

Also, when you consider what is arguably the world’s best-known stock gauge, the Dow Industrials, the “volatility” we’re experiencing looks a whole lot like 2006. Last year saw only 26 days during which the Dow moved 1% or more. The last year that saw such a small number of 1% moves was 2006. We only had three days in 2013 when the Dow moved 2% or more, on a closing basis. You have to go back, again, to 2006 to find a year with fewer (there actually were no 2% or greater Dow moves in 2006). Intraday moves of 2% or more? Five so far this year, matching the number in 2006 — vs. an average of 62 in the intervening years.

Why is this important? Because reports suggest that many investors have only recently begun to dip more than a toe back into the market’s waters after either sitting on the sidelines or in bonds for the bull’s four-and-a-half-year run. I would hate to see these investors lulled into the market by the relative complacency with which we’ve been hitting these highs.

And while many would be horrified to hear this, I think a 10% correction — which would take the Dow down more than 1,600 points into the 14,000s rather than the 16,000s — would flush out some of the “traders” who shouldn’t be in the market in the first place. And hopefully, it would revalue some of the stocks that might have become a bit too “rich” in this very, very calm bull market.

Don’t get me wrong — I’ll take the gains we’ve earned as long-term investors. But I’m also cognizant, as you should be, that we’ve seen rising prices lately that have come a bit too easily. That doesn’t mean we can’t earn a positive return down the road, I’m just preparing for a bumpier path than the one we’ve traveled.

This is going to make active management all the more valuable. Investors rushing into stock index funds, particularly ETFs, might be troubled to learn that their money can go down at the same rate as the stock market — in the same fashion that it went up.